Rising Corporate Debt May Be Reaching Dangerous Levels

Corporate debt is rising to potentially dangerous levels in Europe and some emerging markets, according to a new global banking group study.

While many firms across the globe have used years of low-interest borrowing from central banks to bolster their balance sheets, some companies have gone deeper in debt in the hopes of tiding their finances over until better times. Others have borrowed against growth prospects.

They could be a deadly strategies.

“After six years of abundant liquidity and near-zero policy rates, additional easing of monetary conditions could increasingly lead to financial distortions and pockets of bubbles in asset markets,” the Institute of International Finance said in its November Capital Markets Monitor.

Some euro zone countries could come under market pressure again as bad corporate balance sheets weigh on banks that also hold risky sovereign debt. And emerging market economies with weak economic fundamentals may face renewed turbulence as investors rethink their portfolios.

The increase is likely largely driven by those firms with weaker balance sheets and anemic profitability, the global banking group said. The IIF represents more than 450 of the world’s largest financial firms.

High-yield corporate issuances in Europe — loans to the riskiest firms — are already 50% higher this year than last-year’s levels.

“Against the backdrop of recession, sluggish recovery and low inflation, many highly indebted corporate borrowers may already be struggling to service their debt,” the IIF said.

The IMF said banks’ gross losses on corporate loans — estimated around 125 billion euros in Italy, 104 billion euros in Spain and 20 billion euros in Portugal — could be fully absorbed by additional provisioning.

But “the continued decline in bank lending to the corporate sector remains a headwind to economic recovery in the euro area,” the IIF cautioned.

Corporates in emerging market economies, particularly in Asia, have also been taking on more debt.

“These higher levels of debt may present problems for some corporate borrowers,” the IIF said, particularly as earning growth slows.

And while emerging market corporations have issued more bonds in local currencies, the banking group said borrowing in foreign exchange has increased substantially in the past four years, exposing some firms to falling domestic exchange rates.

“During periods of stress in international financial markets, EM corporations with FX debt could experience refinancing and rollover difficulties as well as higher debt burdens if their domestic currencies depreciate strongly against the foreign currencies they’ve borrowed in,” the IIF said.

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